“Governments should not become addicted to borrowing as a quick fix to stimulate demand. … Deficit spending cannot become a permanent state of affairs.”
– Wolfgang Schaeuble,

German finance minister,

Spiegel Online, June 25, 2010

Over the past year, German Chancellor Angela Merkel and Finance Minister Wolfgang Schaeuble have had to defend their austerity plans against criticism from the Obama administration. Our economic team warned Germany that its fiscally conservative programs could throttle a stuttering global recovery.

Instead, Germany is committed to reducing its federal deficit to 35 percent of gross domestic product by 2016 through a combination of reduced expenditures (67 percent) and higher taxes (33 percent).

The countries, compared

German annualized GDP growth in the second quarter was remarkable: almost 9 percent, the best performance since reunification 20 years ago. The American economy grew only at a 1.6 percent annual rate in the second quarter. German unemployment fell to 7.6 percent. America’s unemployment has risen to 9.6 percent. In 2009, according to the International Monetary Fund, German per capita income, $40,875, was only slightly behind the United States, $46,381.

Germany follows a socialist economic model, including a nationalized medical system. The role of the government in the German economy remains high, 44 percent of GDP versus the U.S.’ 25 percent.

Germany also is the largest national economy in Europe, the fourth-largest by nominal GDP in the world. Germany is the world’s second largest exporter, with $1.170 trillion exported in 2009.

Keys to German success

How did Germany accomplish its remarkable economic success when other economies faltered?

Germany emphasized exports. Its companies are globally competitive, producing popular products such as cars and high-end machine tools. Also, starting in 2002, the government instituted a number of programs now known as the Hartz Reforms to achieve long term competitiveness. They:

1. Provided incentives to keep workers employed instead of providing relief after they become unemployed. This “short work” program encouraged companies to furlough workers or employ them for fewer hours instead of firing them.

2. Eased rules for hiring and firing.

3. Limited wage increases.

4. Reduced length of time for receiving unemployment benefits.

Some other reasons why the German economy sizzled while the U.S. economy has fizzled:

Germany’s export economy benefited from the U.S. stimulus program. In June 2010, the U.S. trade deficit increased by nearly 15 percent to $62 billion.

The decline in the value of the euro in the wake of the Greek credit crisis made German-produced goods less expensive.

German labor policies (the Hartz Reforms) ensured very low labor costs relative to economic productivity.

Is there a downside to Germany’s economic success? Yes — for the rest of Europe.

German policies helped its domestic economy rather than fostered regional and global growth. The other members of the euro zone — the 16 countries that adopted the euro currency as their sole legal tender — face major headwinds: severe unemployment, stagnant output, debilitating debt, a deteriorating banking system and an overvalued exchange rate. France’s economy grew at only 0.6 percent, Spain’s at 0.2 percent. Greece’s shrank 1.5 percent.

Why is German austerity more likely to work than U.S. stimulus spending?

In 2009, John Cochrane, the Myron S. Scholes professor of finance at the University Chicago’s Booth School of Business, wrote an essay entitled “Fiscal Stimulus, Fiscal Inflation, or Fiscal Fallacies?” He argued that using deficits to launch fiscal stimulus suppresses private-sector spending and investment. Households and businesses reduce spending for two reasons, Cochrane wrote: first, to build a nest egg to pay for higher taxes and, second, they have lost confidence because top-down spending is often chaotic and unpredictable.

Germany’s current economic indicators amply support Berlin’s view that continued deficit spending to jump-start the economy can be counterproductive.

Originally published in the Sarasota Herald-Tribune